A Deeper Look at Income Inequality

An Analysis of The CBO’s Latest Study on Household Income Distribution and Recommendations for Policymakers

November 17, 2011

KEY POINTS:

The question for policymakers is not how best to redistribute a shrinking economic pie. The focus ought to be on increasing living standards, expanding the pie of economic opportunity, and promoting upward mobility for all.

Conventional wisdom on government’s role in inequality often has it backwards: tax reforms have resulted in a moreprogressive federal income tax; government transfer payments have become less progressive (due in large part to growing entitlement payments to wealthier seniors).

Rather than further divide Americans, there is growing bipartisan consensus to target corporate welfare, to income-adjust entitlement programs, and to reform the tax code by removing loopholes and lowering barriers to growth.

The Congressional Budget Office (CBO) recently released a study on changes in the distribution of household income in America from 1979 to 2007. This study has added fuel to an intensifying debate in Washington and across America over income inequality – what causes it, how do government policies affect it, and what should policymakers do about it?

The primary means by which government policy directly affects income inequality is through the redistribution of wealth via taxes and transfer programs such as Social Security, Medicare, and Medicaid. Therefore, it is not surprising that views on inequality have colored recent debates over debt and deficit reduction, since most deficit-reduction proposals involve changes to tax rates and transfer programs.

As policymakers evaluate competing approaches to deficit reduction, it is important that the impact of past policy changes are properly understood. This is especially true if deficit reduction efforts aim to maximize economic growth, opportunity, upward mobility, and prosperity for all Americans – rather than just to change the distribution of a shrinking economic pie.